RBI has launched cash-settled interest rate futures (IRF) contracts for investors to help them hedge interest rate risks while investing in government bonds.

The central bank has allowed IRF contracts in 91-day Treasury bills and other government bonds. The contract size will be R2,00,000 and will represent 2,000 underlying government bonds, said the Sebi in a separate notification. The tenure of the IRF shall be a maximum of three months.

Interest rate futures are exchange traded derivative products that allow a bond investor to hedge the interest rate risk in the investment. IRFs are a more transparent alternative to the current over-the-counter interest rate swaps.

In the 10-year benchmark government bonds, the RBI has allowed two different designs for cash settled IRFs. One is where the government bond is the underlying and the settlement price would be based on the prices during the last two hours of trading on the Negotiated Dealing System-Order Matching system.

The other option given is where the underlying for the IRF is a basket of government bonds. In this case, the settlement price would be based on the weighted average yield of the basket of bonds, the RBI said.

In an IRF contract with the 10-year government bond as underlying, the final settlement price will be calculated based on prices during the last two hours of the trading, the RBI said in a release on Thursday.

The cash settled 10-year IRF is being introduced on a pilot basis and the product features would be reviewed based on experience, said Sebi in it's circular.

Sebi has capped the gross open positions of market participants at 3% of the total open interest or R200 crore, whichever is higher.

Further, the gross open positions of trading members or brokers across all contracts must not exceed 10% of the total open interest or R600 crore, whichever is higher, the capital market regulator added.

FIIs can also hedge their bond investments through IRFs, the RBI said.